How Overtime Reform Will Grow the Economy from the Middle Out

By Brendan Duke
August 6, 2014, 9:04 am

Our overtime system is broken. Just 8 percent of full-time salaried workers have guaranteed overtime rights today. And unless the Department of Labor modernizes the overtime rules, 0 percent will have them by 2026 if current trends continue.*

Without guaranteed overtime rights, employers can easily misclassify workers who spend most of their time at the cash register or restocking shelves as overtime-exempt “executives” or “professionals” and avoid paying them overtime—1.5 times their hourly wage or the equivalent for salaried workers.

That is why the Obama administration has proposed modernizing overtime rules, specifically the “salary threshold”—the weekly salary below which workers have guaranteed overtime rights. In 1975, the salary threshold stood at $960 per week—$50,000 per year—but failure to raise the threshold with inflation has left it at a mere $455 per week, or $24,000 per year. Raising the threshold back to $50,000 would re-establish overtime rights for more than 40 percent of full-time salaried workers.*

The moral argument for overtime reform is straightforward: When Americans work extra hours, they should earn extra dollars. But the economic case is equally strong.

Modernizing overtime rules would help the middle class rebuild our economy in three ways: First, workers would have extra money and spend it; second, firms would have an incentive to hire new workers; and third, it would reduce long workweeks, which drain our future human capital, the key ingredient for future economic growth.

Here is how overtime reform would empower the middle class to strengthen our economy from the middle out.

1. Boosting consumer demand by boosting workers’ paychecks

Lack of consumer demand is still holding our economy back. Chicago Federal Reserve President Charles L. Evans recently noted that, “The U.S. consumer is slowly improving but is just a shadow of its former self.” The middle class punches above its economic weight in consumer spending because it spends a higher percentage of its income than the rich do. But stagnant wages and substantial housing debt are preventing the middle class from restoring consumer spending—and our economy—back to its prerecession trend.

Increasing the salary threshold would increase the take-home pay for workers who become eligible for overtime pay for their extra hours, allowing them to purchase goods and services. Updating the overtime rule would grow the economy much the same way increasing the minimum wage would. A recent Chicago Federal Reserve study, for example, found that a minimum-wage hike would immediately increase gross domestic product, or GDP, by 0.3 percent by putting money in the pockets of workers who will spend it. Paying workers for overtime would allow middle-class households without much cash or credit to spend money, which in turn would give companies a reason to hire.

Some critics argue that modern overtime rules would have no effect on wages because employers would simply lower employees’ base wages to keep take-home pay the same. But the very studies they cite show “these adjustments are not large enough to neutralize overtime pay regulation completely,” and they estimate workers still receive 30 percent extra pay after accounting for these effects—an “effective overtime premium.”

Most importantly, modern overtime rules will likely do the most for worker pay in the short run—when we need demand the most—since employers are unlikely to cut wages immediately. Substantial evidence shows that employers do not cut wages; rather, they prefer to let inflation erode them.

2. An incentive to hire new workers

It’s hard to stay in the middle class without a job. Although the unemployment rate has fallen since the depths of 2009, the labor market is still broken—labor-force participation for 25- to 55-year-olds sits at a 30-year low. Most disturbing has been the persistently high number of long-term unemployed workers, who account for one-third of the unemployed. Long-term unemployment threatens to permanently shrink the middle class and our potential output even after the economy recovers, since long-term unemployed workers may leave the labor force entirely.

Worker hours have almost recovered to their prerecession level amid high levels of unemployment, implying that firms have preferred to meet slowly recovering demand with more hours from current workers instead of hiring new ones. The higher wages that would result from a salary threshold increase would create a much-needed incentive for firms to hire new workers by raising the cost of current workers’ overtime pay.

A higher salary threshold would encourage firms to hire new workers, including the long-term unemployed, directly reducing unemployment, rebuilding the middle class, and helping our economy grow. Evidence suggests that long-term unemployed workers are just as productive as other workers once they find a job. Giving firms an incentive to hire new workers could prevent the long-term unemployed from leaving the labor force permanently, which threatens to diminish our long-term GDP potential.

3. Investing in human capital

The next generation’s education levels will determine our future economic growth: Different levels of educational attainment and quality go a long way toward explaining why some countries grow quickly and others grow slowly. Overworked parents are a barrier to increasing the educational and cognitive development for today’s children, and eliminating barriers will have a big economic payoff down the road.

Involved parents—whether in infancy or high school—increase children’s educational attainment. But it’s harder for parents to stay involved when they work long hours: Young children whose mothers or fathers work more than 40 hours per week score worse on verbal tests than children whose parents work full time. This coincides with research showing that closely linked night or evening work is especially harmful for children’s reading and math scores.

Overtime work and late hours thus have a large cost to society by reducing our future growth potential. But employers can currently compel overtime-exempt employees to work more than 40 hours per week without paying that social cost. Econ 101 teaches us that employers will thus buy too many overtime hours because they are cheap at the expense of human capital development and future growth. But basic economics also offers a solution: Raising the price of overtime hours by raising the salary threshold would encourage employers to buy fewer overtime hours. Evidence from changes in California’s overtime law suggests that this is exactly what would happen.

Requiring employers to pay a premium for hours that hurt the nation’s current and future human capital stock is not onerous regulation—it’s a way of increasing long-run economic efficiency.

Conclusion

Modernizing overtime rules is smart policy, as it would help the United States deal with three economic challenges: low aggregate demand, slow hiring of the long-term unemployed, and stagnant human capital growth. It would put money in workers’, and thus consumers’, pockets; create an incentive for companies to hire workers, including the long-term unemployed; and help build the stock of human capital that we know is the deciding factor in long-term economic growth.

The middle class is the engine of U.S. economic growth. It buys the goods and services, starts the companies from which shareholders profit, and supports the political institutions that create efficient markets. But after 30 years of working harder and longer, middle-class workers have not gotten a raise. A strong overtime rule could be just the boost that the middle class and our economy need.

Brendan V. Duke is a Policy Analyst for American Progress’ Middle-Out Economics project.

* Correction, November 17, 2014: This column has been corrected to reflect the fact that most employees paid on an hourly basis have guaranteed overtime rights.